Samstag, 30. April 2011

Interview: Prof. David Andolfatto, Simon Faser University, Canada

David Andolfatto is Professor of Economics and a Vice President in the Research Division of the Federal Reserve Bank of St. Louis.

What is your take on the “don’t fight the Fed”, one of the old truism on Wall Street?

“Don’t fight the Fed” is an old Wall Street adage that warns traders not to make bets against the Fed. The adage assumes that the Fed has the ability to influence the interest rates that determine asset prices in the equity and bond markets. So, for example, if the Fed can make equity prices rise by lowering interest rates (say, via open market bond purchases), then the adage warns traders not to take short positions on equities when the Fed is expected to lower interest rates.

I’m not sure what to make of the adage. It might serve as a useful rule of thumb for bond traders. The influence of monetary policy on equity prices over medium to long horizons is probably not very big. Like most Wall Street adages, it is probably close to useless. There are many other more important factors that determine real asset values.

Why are the central banks in developed countries currently under massive criticism, because they are apprehending their role as “lender of last resort”?

Central banks are always under criticism. The criticisms levelled against the Fed seem based largely on public misperception of what the Fed does in general and what the Fed did during the financial crisis in particular.

People do not understand monetary policy; they often confuse it with fiscal policy. People have the view that the Fed prints money and then spends it (or gives it away to favoured individuals or institutions). In fact, the Fed can only use newly printed money to purchase assets or, what amounts to the same thing, extend loans against high grade collateral. There are a few minor exceptions to this, but by and large what we are talking about here are asset swaps, not helicopter drops.

A good fraction of the Fed’s portfolio of assets now includes high-grade mortgage backed securities (MBS). These MBS products were issued after the sizable drop in home prices. They are AAA-rated and insured by the Treasury. They currently generate about a 5% annual rate of return. Last year, the Fed remitted a record profit to the Treasury.

People also do not understand what the Fed did during the financial crisis. There is a widespread perception that the Fed simply bailed out a number of rich bankers and other favoured individuals.

Consistent with its lender-of-last-resort mandate, the Fed did open a number of emergency lending facilities during the financial crisis. The Fed lent money against what it viewed as high-grade, but excessively discounted, collateral. Given that the Fed made the taxpayers a tidy profit on these operations (while achieving the intended effect of keeping markets liquid), one is hard pressed to interpret this intervention as a “bailout.” Even the notorious Bear Stearns and AIG interventions now appear likely to generate a profit. By and large, I do not think that this is widely understood by the general public.

How immune is the Fed to politics?

The Fed was created by Congress in 1913 under the Federal Reserve Act. The Fed was created by Congress, the Fed reports to Congress, and the Fed can be destroyed by Congress. So ultimately, the Fed is not immune from politics.

The original founders of the Fed, however, understood the benefits of distancing monetary policy from Congressional politics. There are mechanisms in place that currently allow the Fed to operate independently of Congress. Having said this, one has to recognize that the Fed is always under political pressure. There have been times in its history where it has bowed to such pressure. But there have also been times when the Fed offered stiff and stubborn resistance to such pressure. The degree of independence may be governed in part by the personalities involved.

Thank you very much.

David Andolfatto is a Vice President in the Research Division of the Federal Reserve Bank of St. Louis. His current research is focused on reconciling theories of money and banking. His past research has examined questions relation to the business cycle, contract design, bank-runs, unemployment insurance, monetary policy regimes, endogenous debt constraints and technology diffusion. His blog: MacroMania.

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